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Tuesday, January 10, 2017

“Whether in view of the settled principle that HUF cannot be a registered shareholder in a company and hence could not have been both registered and beneficial shareholder, loan/advances received by HUF could be deemed as dividend within the meaning of Section 2(22)(e) of the Income Tax Act, 1961 especially in view of the term “concern” as defined in the Section itself?”=Though, the share certificates were issued in the name of the Karta, Shri Gopal Kumar Sanei, but in the annual returns, it is the HUF which was shown as registered and beneficial shareholder. In any case, it cannot be doubted that it is the beneficial shareholder. Even if we presume that it is not a registered shareholder, as per the provisions of Section 2(22)(e) of the Act, once the payment is received by the HUF and shareholder (Mr. Sanei, karta, in this case) is a member of the said HUF and he has substantial interest in the HUF, the payment made to the HUF shall constitute deemed dividend within the meaning of clause (e) of Section 2(22) of the Act. This is the effect of Explanation 3 to the said Section, as noticed above. Therefore, it is no gainsaying that since HUF itself is not the registered shareholder, the provisions of deemed dividend are not attracted. For this reason, judgment in C.P. Sarathy Mudaliar, relied upon by the learned counsel for the appellant, will have no application. That was a judgment rendered in the context of Section 2(6- A)(e) of the Income Tax Act, 1922 wherein there was no provision like Explanation 3. We, thus, do not find any merit in this appeal, which is accordingly dismissed.

The appellant/assessee, in the instant appeal, has raised
following question of law for determination:
“Whether in view of the settled principle that HUF cannot be a registered
shareholder in a company and hence could not have been both registered and
beneficial shareholder, loan/advances received by HUF could be deemed as
dividend within the meaning of Section 2(22)(e) of the Income Tax Act, 1961
especially in view of the term “concern” as defined in the Section itself?”

The aforesaid question has arisen, which pertains to Assessment Year 2006-
07, under the following circumstances:

The assessee herein had filed the return in respect of the said Assessment
Year declaring his total income at Rs. 1,62,745/-. The Assessing Officer
(for short, 'AO') carried out the assessment resulting into passing of
assessment orders dated 31st December, 2008 whereby the net income of the
assessee was calculated at Rs. 1,30,31,280/-. Obviously, number of
additions were made which contributed to the enhancement of income to the
aforesaid figure, in contrast with the paltry income declared by the
assessee. Here, we are concerned only with one addition which was made on
account of deemed dividend within the meaning of Section 2(22)(e) of the
Income Tax Act, 1961 (hereinafter referred to as the 'Act'). Suffice it to
state that other additions were deleted by the Income Tax Appellate
Tribunal (ITAT) and the position affirmed by the High Court, but the
Revenue has not challenged those deletions.

Insofar as addition under Section 2(22)(e) of the Act is concerned, a sum
of Rs. 1,20,10,988/- was added on this account. The assessee is a Hindu
Undivided Family (HUF). During the previous year to the Assessment Year,
the assessee had received certain advances from one M/s. G.S. Fertilizers
(P) Ltd. (hereinafter referred to as the 'Company'). The Company is the
manufacturer and distributor of various grades of NPK Fertilizers and other
agricultural inputs. In the audit report and annual return for the relevant
period, which was filed by it before the Registrar of Companies (ROC), it
was found that the subscribed share capital of the said Company was Rs.
1,05,75,000/- (i.e., 10,57,500 shares of Rs. 10/- each). Out of this,
3,92,500 number of shares were subscribed by the assessee which represented
37.12% of the total shareholding of the Company. From this fact, the AO
concluded that the assessee was both the registered shareholder of the
Company and also the beneficial owner of shares, as it was holding more
than 10% of voting power. On this basis, after noticing that the audited
accounts of the Company was showing a balance of Rs. 1,20,10,988/- as
“Reserve & Surplus” as on 31st March, 2006, this amount was included in the
income of the assessee as deemed dividend.

In the appeal filed by the assessee, the aforesaid addition was affirmed by
the Commissioner of Income Tax (Appeals) (for short 'CIT(A)'). Though,
this addition was questioned by the assessee on various grounds, we would
take note of the submission which is advanced before us as the challenge is
confined only on the basis of said submission. The assessee had argued
that being a HUF, it was neither the beneficial shareholder nor the
registered shareholder. It was further argued that the Company had issued
shares in the name of Shri Gopal Kumar Sanei, Karta of the HUF, and not in
the name of the assessee/HUF as shares could not be directly allotted to a
HUF. On that basis, it was submitted that provisions of Section 2(22)(e)
of the Act cannot be attracted.

We would like to reproduce that portion of Section 2(22)(e) of the
Act at this stage, which is relevant for the instant appeal:

“S.2(22) of the Income Tax:- Dividend includes:
xxx xxx xxx
(e) any payment by a company, not being a company in which the public are
substantially interested, of any sum (whether as representing a part of the
assets of the company or otherwise) [made after the 31st day of May, 1987,
by way of advance or loan to a shareholder, being a person who is the
beneficial owner of shares (not being shares entitled to a fixed rate of
dividend whether with or without a right to participate in profits) holding
not less than ten per cent of the voting power, or to any concern in which
such shareholder is a member or a partner and in which he has a substantial
interest (hereafter in this clause referred to as the said concern)] or
any payment by any such company on behalf, or for the individual benefit,
of any such shareholder, to the extent to which the company in either case
possesses accumulated profits;

but “dividend” does not include—

xxx xxx xxx

Explanation 3.— For the purposes of this clause,

(a) “concern” means a Hindu undivided family, or a firm or an association
of persons or a body of individuals or a company;

(b) a person shall be deemed to have a substantial interest in a concern,
other than a company, if he is, at any time during the previous year,
beneficially entitled to not less than twenty per cent of the income of
such concern.”

Taking note of the aforesaid provision, the CIT(A) rejected the aforesaid
contention of the assessee. The CIT(A) found that examination of annual
returns of the Company with Registrar of Company (ROC) for the relevant
year showed that even if shares were issued by the Company in the name of
Shri. Gopal Kumar Sanei, Karta of HUF, but the Company had recorded the
name of the assessee/HUF as shareholders of the Company. It was also
recorded that the assessee as shareholder was having 37.12% share holding.
That was on the basis of shareholder register maintained by the Company.
Taking aid of the provisions of the Companies Act, the CIT(A) observed that
a shareholder is a person whose name is recorded in the register of the
shareholders maintained by the Company and, therefore, it is the assessee
which was registered shareholder. The CIT(A) also opined that the only
requirement to attract the provisions of Section 2(22)(e) of the Act is
that the shareholder should be beneficial shareholder. On this basis, the
addition made by the AO was upheld.

Undeterred, the assessee approached the next higher forum, i.e., ITAT in
the form of appeal under Section 253 of the Act. In this endeavour, the
assessee succeeded as appeal of the assessee was allowed holding that the
ingredients of Section 2(22)(e) of the Act were not satisfied and,
therefore, addition of the aforesaid nature could not be made.
For this purpose, the ITAT referred to the judgment
rendered by its Mumbai Bench in the case of Binal Sevantilal Koradia (HUF)
Vs. Department of Income Tax[1]. In fact, the only exercise done by the
ITAT in the said order was to quote from the aforesaid judgment with the
observations that the issue is squarely covered by the said decision. In
Koradia (HUF), it was held by the Tribunal that HUF cannot be said to be
shareholder or a beneficial shareholder. Since these are the twin
conditions to attract the provisions of Section 2(22)(e) of the Act, both
have to be satisfied. As per the ITAT, since HUF, in law, cannot be a
registered shareholder or a beneficial shareholder, provisions of Section
2(22)(e) would not be attracted.

As noticed above, the High Court, in the impugned judgment rendered in the
appeal preferred by the Revenue, has reversed the judgment of the ITAT,
thereby restoring the addition which was made by the AO. The order of the
High Court reveals that it has done nothing but to extract the language of
Section 2(22)(e) of the Act and sustained the addition made by AO with one
line observation, viz., 'the assessee did not dispute that the Karta is a
member of HUF which has taken the loan from the Company and, therefore, the
case is squarely within the provisions of Section 2(22)(e) of the Income
Tax Act'.

The arguments before us remain the same. Mr. S.B. Upadhyay, learned senior
counsel appearing for the assessee, argued that the ITAT had correctly
explained the legal position that HUF cannot be either beneficial owner or
registered owner of the shares and, therefore, no addition could be made
under Section 2(22)(e) of the Act. For buttressing this submission, the
learned counsel relied upon the following observations in judgment of this
Court in CIT, Andhra Pradesh Vs. C.P. Sarathy Mudaliar[2]:

“....It is well settled that an HUF cannot be a shareholder of a company.
The shareholder of a company is the individual who is registered as the
shareholder ion the books of the company. The HUF, the assessee in this
case, was not registered as a shareholder in books of the company nor could
it have been so registered. Hence there is no gain-saying the fact that
the HUF was not the shareholder of the company.”

Learned Additional Solicitor General, on the other hand, after reading the
relevant portions of the orders of AO and CIT(A), submitted that on the
facts of this case, the Revenue was justified in making the addition.

Section 2(22)(e) of the Act creates a fiction, thereby bringing any amount
paid otherwise than as a dividend into the net of dividend under certain
circumstances. It gives an artificial definition of 'dividend'. It does
not take into account that dividend which is actually declared or received.
The dividend taken note of by this provision is a deemed dividend and not
a real dividend. Loan or payment made by the company to its shareholder is
actually not a dividend. In fact, such a loan to a shareholder has to be
returned by the shareholder to the company. It does not become income of
the shareholder. Notwithstanding the same, for certain purposes, the
Legislature has deemed such a loan or payment as 'dividend' and made it
taxable at the hands of the said shareholder. It is, therefore, not in
dispute that such a provision which is a deemed provision and fictionally
creates certain kinds of receipts as dividends, is to be given strict
interpretation. It follows that unless all the conditions contained in the
said provision are fulfilled, the receipt cannot be deemed as dividends.
Further, in case of doubt or where two views are possible, benefit shall
accrue in favour of the assessee.

A reading of clause (e) of Section 2(22) of the Act makes it clear that
three types of payments can be brought to tax as dividends in the hands of
the share holders. These are as follows:
(a) any payment of any sum (whether as representing a part of the assets
of the company or otherwise) by way of advance or loan to a shareholder.

(b) any payment on behalf of a shareholder, and

(c) any payment for the individual benefit of a shareholder.

[See: Alagusundaran Vs. CIT; 252 ITR 893 (SC)]

Certain conditions need to be fulfilled in order to attract tax under this
clause. It is not necessary to stipulate other conditions. For our
purposes, following conditions need to be fulfilled:
(a) Payment is to be made by way of advance or loan to any concern
in which such shareholder is a member or a partner.
(b) In the said concern, such shareholder has a substantial
interest.
(c) Such advance or loan should have been made after the 31st day of
May, 1987.

Explanation 3(a) defines “concern” to mean HUF or a firm or an association
of persons or a body of individuals or a company. As per Explanation 3(b),
a person shall be deemed to have a substantial interest in a HUF if he is,
at any time during the previous year, beneficially entitled to not less
than 20% of the income of such HUF.

In the instant case, the payment in question is made to the assessee which
is a HUF. Shares are held by Shri. Gopal Kumar Sanei, who is Karta of this
HUF. The said Karta is, undoubtedly, the member of HUF. He also has
substantial interest in the assessee/HUF, being its Karta. It was not
disputed that he was entitled to not less than 20% of the income of HUF.
In view of the aforesaid position, provisions of Section 2(22)(e) of the
Act get attracted and it is not even necessary to determine as to whether
HUF can, in law, be beneficial shareholder or registered shareholder in a
Company.

It is also found as a fact, from the audited annual return of the Company
filed with ROC that the money towards share holding in the Company was
given by the assessee/HUF. Though, the share certificates were issued in
the name of the Karta, Shri Gopal Kumar Sanei, but in the annual returns,
it is the HUF which was shown as registered and beneficial shareholder. In
any case, it cannot be doubted that it is the beneficial shareholder. Even
if we presume that it is not a registered shareholder, as per the
provisions of Section 2(22)(e) of the Act, once the payment is received by
the HUF and shareholder (Mr. Sanei, karta, in this case) is a member of the
said HUF and he has substantial interest in the HUF, the payment made to
the HUF shall constitute deemed dividend within the meaning of clause (e)
of Section 2(22) of the Act. This is the effect of Explanation 3 to the
said Section, as noticed above. Therefore, it is no gainsaying that since
HUF itself is not the registered shareholder, the provisions of deemed
dividend are not attracted. For this reason, judgment in C.P. Sarathy
Mudaliar, relied upon by the learned counsel for the appellant, will have
no application. That was a judgment rendered in the context of Section 2(6-
A)(e) of the Income Tax Act, 1922 wherein there was no provision like
Explanation 3.

We, thus, do not find any merit in this appeal, which is accordingly
dismissed.
.............................................J.
(A.K. SIKRI)